What Is a Balance Transfer and How Does It Work?

The credit card industry is incredibly competitive, and card issuers will go to great lengths to acquire new customers. One of the tools they use to do that is a balance transfer, a transaction where existing credit card debt is moved to a new card.

How do credit card balance transfers work?

If your credit card issuer offers balance transfers (and most do), then you can contact them and ask to perform a balance transfer. The card issuer will need to know the name of the of the issuer of the card you want to transfer the balance from, its account number and the amount you wish to transfer. Just note that you cannot transfer a balance between two accounts held by the same card issuer.

Then you have to wait for the transfer to go through and the credit processed to the account you're transferring the balance from. In the mean time, you'll still incur interest charges on the account you're transferring the balance from, and you'll still need to make any payments that are due on the account.

Once the new balance appears on the account you transferred it to, it will be subject to the account's interest rate for balance transfers. This could be 0% APR or a lower, promotional interest rate. However, it could also be the same rate that applies to new purchases, so check your card's term and conditions.

In addition to the amount transferred to the new account, the transferring card issuer will often add a balance transfer fee. These fees are imposed by nearly all card issuers offering 0% APR promotional transfers, and are usually either 3% or 5% of the amount transferred. This fee is added to the new balance and incurs interest at the same rate as the rest of the balance transferred. However, there are many cards that offer balance transfers at the standard interest rate that don't have a balance transfer fee.

If the card has a 0% APR rate, the you won't incur interest charges on your amount transferred until the promotional rate expires. Then, you'll incur charges at the standard rate for balance transfers. Also, keep in mind that any payment you make above your minimum payment will first be applied to the balance with the highest interest rate, which won't be a 0% APR balance transfer.

When should you apply for a balance transfer credit card?

The primary goal of a balance transfer is to save money on interest charges. This is easy to do when you open a new account that offers 0% APR promotional financing on balance transfers. As long as you anticipate saving more money on interest charges than you will spend on the balance transfer fee, this strategy will make financial sense. Not only will you avoid paying a lot of money in interest charges, all of your monthly payments will go towards the principal, allowing you to pay off your balance sooner. But once again, note that your payments will first go towards any purchases you made on that account that incur a balance, before being applied to your 0% APR balance transfer.

For example, if you have a $5,000 outstanding balance, and you transfer it to a new card that offers 15 months of interest free financing on balance transfers. This transfer has the potential to save the cardholder hundreds of dollars in interest charges over that time, even when you consider a 3% or even a 5% balance transfer fee. But if the cardholder was willing and able to pay off that balance within a few months, than the balance transfer fee could be greater than the amount of interest saved.

It can also make sense to transfer a balance to a card without a 0% APR promotional financing offer, so long as it has a significantly lower interest rate, and there's no balance transfer fee. For instance, if you have a card with a 25% APR, and you can transfer your balance to a card with an 18% APR, you will save a tremendous amount on interest charges, allowing you to pay off your balances sooner.

What to know about balance transfer credit cards and your credit score

When using credit cards, one of the concerns you should always have is how your actions will affect your credit history and your credit score. When you apply for any new credit card, including a balance transfer card, you are making an inquiry into your credit. One inquiry by itself will have little effect, but if you have several inquiries in a short time period, then it can have a significant, but temporary effect on your credit score. That's because multiple new requests for credit can be seen as a sign of possible financial distress.

Once you are approved for the new account, you will have an additional loan on your credit history. When you make on-time payments, this will add positive information to your credit history and can help your credit score.

Transferring a balance, by itself, won't have any direct impact on your credit. But if taking advantage of a 0% APR balance transfer offer allows you to postpone repayment of your debt, this can have a negative effect on your credit compared to paying off your debt. The amounts owed makes up 30% of your FICO score and is the second most important factor after your payment record. So even if your balance isn't incurring interest, paying it down or paying it off altogether will help to raise your credit score.

How to choose the best balance transfer credit card

There are many credit cards that offer 0% APR introductory financing for balance transfers. Among these offers, the two most important terms to consider are the length of the promotional financing period, and the balance transfer fee.

By law, promotional financing offers must last a minimum of six months. But the most competitive offers will last 12-18 months, and occasionally even longer. The longer the offer extends, the more valuable it is. The other major factor is the card's balance transfer fee. Nearly all cards with 0% APR balance transfer offers will have a fee of either 3% or 5%, but on rare occasions there have been cards with no fees for transfers completed shortly after you open an account. Since the amount of the fee is added on to your new balance, a lower fee is much better than a higher one.

Beyond the length of the promotional financing period, and the amount of the balance transfer fee, you'll want to consider other aspects of the credit card. For example, does it have an annual fee, can you earn rewards and does it offer any kind of bonus for new applicants. Finally, you can look at cardholder benefits such as travel insurance and shopping protection, which can be extremely valuable.

For more on balance transfer cards and how to choose the right one for you, make sure to check out our picks for Best Balance Transfer Cards.